Creative Deal Structuring

CREATIVE DEAL STRUCTURING: EARNOUT AGREEMENTS

Acquisition talks are proceeding smoothly. Then the subject of price comes up. The buyer thinks the seller’s asking price is based on overly optimistic financial projections. The seller believes the buyer’s valuation of his company is far too low. Is the deal dead? Not necessarily. An earnout agreement can help resolve the dispute when a buyer and seller disagree about the seller’s business prospects. They are especially useful when dealing with the unknown — when the target is young and unproven, or it is emerging from a difficult financial situation. In short, earnouts offer a way for the parties to bridge expectation gaps.

business dealUnderstand the benefits

In an earnout, a buyer makes a partial, upfront payment to the seller. With the payment comes a promise to pay the rest of an agreed-on amount if the target meets certain pre-established goals. Meeting these goals generally results in a higher price for the seller, while falling short of the goals may result in a lower price. A well-designed earnout carries advantages for both parties. For instance, the buyer can initiate a transaction with a relatively modest amount of cash. It also can avoid the risk of paying too much for a company unable to deliver on overly optimistic financial projections. Finally, an earnout can help make the transaction more valuable by significantly motivating the seller to achieve its promised results. The seller, meanwhile, can use an earnout to help negotiate a better asking price. An earnout can be particularly helpful when the seller believes that the company’s future results are likely to be much better than its current ones.

Structure the agreement solidly

Whether an earnout succeeds can depend on how well it’s structured. An ill-considered and vague agreement can turn a dispute over valuation into a dispute about the agreement itself. A common problem is drafting an earnout that covers an inadequate period. When this happens, the seller may try to quickly boost its earnings, even at the expense of the company’s long-term financial health. By expanding the earnout period, the buyer can collect more data to evaluate the target’s financial performance. Many experts say an earnout should reflect at least a year’s worth of results and perhaps as much as three years’ worth. Keep in mind, however, that the seller’s business becomes increasingly influenced by the buyer’s management — setting the stage for finger-pointing if the seller fails to meet the earnout’s terms. The earnout also should include the right measures of financial success. Gross sales figures provide one popular measure because they’re more difficult to manipulate than net sales. Net earnings, though a good long-term measure, are subject to many variables and can be misleading over a short period.

Achieve consensus quickly

Even the best-structured earnout needs occasional monitoring. A good way to keep the agreement on track and minimize the potential for later disputes is to include a provision for periodic audits. Audits help reassure the buyer that the target is using appropriate accounting methods and operating its business professionally. A poorly conceived earnout will fail to achieve a consensus between buyer and seller, who may interpret the same facts in vastly different ways. Thus, earnouts often include a dispute-resolution mechanism, such as arbitration, which can be a less expensive alternative to litigation.

Every Business Is A Risky Business!

business riskEvery business faces risks, but some companies are riskier than others. Assessing  a company’s risk is an important part of estimating its value. Risk and value are inversely related. That is, the higher a company’s risk, the lower its value. Risk is a function of a company’s external threats and internal weaknesses, but these forces only tell part of the story. On the flip side, a business’s strengths and opportunities minimize risk and, therefore, build value. A Business Intermediary can help you further understand the relationship between risk and value, but remember when valuators focus exclusively on one side of the story, their conclusions are likely to be skewed. For example, to minimize an estate’s tax burden, an appraiser might unduly emphasize a company’s weaknesses and threats to justify excessive valuation discounts. Conversely, the IRS’s expert might downplay these negative elements and, instead, call attention to the business’s strengths and opportunities.

Framework for evaluating risk

Providing a complete, accurate depiction of a company’s future performance requires the valuator to consider both positive and negative aspects of its operations.A strengths, weaknesses, opportunities and threats (SWOT) analysis provides a four-pronged framework for analyzing risk that links a business’s internal strengths and weaknesses to the opportunities and threats in its external environment. This popular tool helps valuators organize their thoughts and provides a holistic risk assessment.

1.      External forces: opportunities and threats.

Before jumping head first into a company’s financial performance and operations, the valuator assesses the external environment in which a company operates.

Opportunities are favorable conditions that — if exploited — may enhance shareholder value. Alternatively, threats are barriers that jeopardize future performance. In many cases, management has little control over these external factors.

2.      Internal forces: strengths and weaknesses.

After the valuator understands the company’s external forces, he or she is ready to identify its internal strengths and weaknesses relative to its competitors’. Strengths are competitive advantages or core competencies that enhance value. In contrast, To complicate matters, strengths and weaknesses sometimes overlap. Consider former Disney CEO Michael Eisner. Although he fueled the company’s financial revival in the late 1980s and 1990s, Eisner’s inability to train a suitable successor has depressed the entertainment giant’s stock in recent years.

3.      Strategic management.

During the valuation process, the valuator also addresses whether a company recognizes and manages its strengths, weaknesses, opportunities and threats. Are the company’s short- and long-term goals congruent with these factors? Does management plan to mitigate threats and correct weaknesses? Is the company taking advantage of potential opportunities and exploiting its strengths? A company’s value can be adversely affected if management is unaware of these internal and external factors or if management fails to incorporate them into its strategic plans.

4.      Impact of information on value estimate.

Finally, valuators use the information obtained from their analyses to help them:

_ Select the appropriate valuation technique,

_ Forecast future income streams,

_ Decide on relevant selection criteria and other subjective adjustments under the market approach,

_ Build discount and capitalization rates when using the income approach, and

_ Quantify valuation discounts, such as discounts for lack of marketability and control.

Review and investigate

In adversarial situations, a valuator’s subjective decisions may come under attack. Attorneys and clients need to review valuators’ written reports to ensure that all risk factors have received adequate attention. They also should investigate exactly how these risk factors affect the appraiser’s computations and assess whether any factors have been double-counted. Above all else, a valuator’s subjective decisions should be well supported and reasonable. Contact a Business Intermediary to find out more about business value vs risk, buying a business or selling your existing business.

 

The VR Transaction Process: 20 Steps To A Successful Sale – Part 1

With over 30 years of experience in selling small to medium enterprises (SME), VR has developed a dynamic and effective Transaction Process to promote a win/win outcome for both Buyer and Seller.  Over the next two blog entries, we shall be sharing with you the 20 Step VR Process to Selling your business.  Here are the first 10 Steps to a successful sale:

1.     Initial Meeting:

The initial meeting serves as an introduction to VR and explanation on how VR can help maximize the value of your business and answer any questions. During this meeting your VR Intermediary will ask to review your business tax returns, company financials, brochures and sales materials, and any other pertinent information to understand your company.

Read the full article here.

What Buyers Look For In A Business Opportunity

You have built a great business with love and care. It has grown larger than you’d
ever imagined, and generates a nice profit that has allowed you and your family to live
comfortably. Now you’re ready to sell. You assume there’s a buyer out there who will
pay you a fair price and then nurture the company with the same attention you have. What’s more, selling the business is a major part of your retirement plan.

Needless to say, buyers look at businesses differently than sellers. So to achieve the
outcome you want, it’s important to think like buyers and understand how they evaluate a business.

What buyers look for

There are many types of buyers: strategic and financial, individuals, companies, and
private equity funds. Despite differences, all buyers consider how much they’ll invest
to acquire a business, the amount of risk they’ll bear and the potential return on their
investment. To evaluate an opportunity, buyers focus on three major areas:

1. Cost and terms.

What will it take to acquire the business? How much cash and how much debt?
What are the deal’s terms and conditions?

2. Continuity

Will the business continue to operate similarly after the sale? Much of the risk of
buying a company relates to continuity. For example:

_ The current owner has personal relationships with customers, distributors or vendors that the new owners may have to struggle to maintain,

_ The owner has special expertise that is undocumented and difficult to learn,

_ Key personnel aren’t committed to staying, or

_ Offshore competition looms.

Sellers armed with solid responses to these types of continuity concerns are more likely to get their desired price. Even if you don’t want to sell your business for a few years, take steps now to ensure it can run smoothly without your personal involvement.

That independence could be worth millions when you sell.

3. Growth

Are there unexploited opportunities? You may have focused your sales efforts in
one geographic region, but there may be many opportunities to take the
product national or international. A buyer that believes it can increase revenues
substantially will pay more for the business than one that believes the current
owners have already maximized opportunities.

What sellers should do?

It may seem counterintuitive, but the things you may be most proud of can work against getting the best price for your company. Not many entrepreneurs like to boast that their company could run just fine without them or that there are plenty of opportunities they’ve failed to exploit. Yet these may be the very factors buyers seek, along with lower cash requirements. Please call us for help in understanding how to best present your company for sale.

December 12, 2012 Market Update

Well today is 12/12/12 and other than the fact it won’t happen again for 100 years (on which the date will be 12/12/2112 for Rush fans out there) I really don’t understand the significance but I digress.

A slow but positive morning as Europe is up on some great employment numbers out of the UK. Unemployment declined by 82000 in Q3 which is the biggest drop in over 11 years! Markets are showing a quarter point increase at midday.

In the US the FOMC concludes the two day meetings today and it would seem that we may see some further stimulus as the bond market is telling all that inflation is not an issue at present. That has the futures up about a quarter point in early trading.

Gold is trading higher by $8.00 back up through $1715 this morning and oil is up a half a point to $86.28.

As we get closer to the holidays we are seeing volumes decline somewhat but the current trend remains positive.

Lastly this morning some information for all around the holiday season:

– last trading day in Canada for settlement this year (tax loss selling) is Monday December 24th, 2012.

– last trading day in the US for settlement this year is Wednesday December 26th, 2012.

– Markets are open for the full day Monday December 24th, 2012.

– The Canadian markets are closed Tuesday and Wednesday December 25th and 26th and reopen Thursday December 27th.

– The US markets are closed on Tuesday December 25th and reopen Wednesday December 26th (as it is a statutory holiday in Canada our offices will be closed December 26th).

– Markets in both Canada and the US are open for the full day Monday December 31st, closed New Year’s Day and reopen Wednesday January 2nd, 2013.

 

6 Strategies to Surviving a Tight Credit Environment

Tight CreditTightened credit conditions are almost inevitable when the economy slows down. The cost of credit rises and lenders naturally become more risk-averse. There’s no way to get around the reality of tighter credit markets, but certain strategies can help your business survive – and even grow – during the downturn.

Consider these six strategies:

Keep lenders in the loop. Communicate proactively and frequently with your lenders, instead of waiting until you have an urgent need or problem. Keep them abreast of your company’s strategic plans and share your successes. But also let them know as soon as possible about potential issues. Your lenders are likely facing increased scrutiny themselves, and will feel more comfortable knowing you’re keeping them in the loop about how your company is doing.

View the full business article here.

Understanding How To Find and Buy The Right Business

Understanding Your Strengths and Weaknesses before Buying a Business

by Peter King, CEO of VR Business Sales

When you’re coming close to buying a business, you will want to investigate and research every objective you have. You will want to see what the alternatives to achieve these goals are……Click here to read full article
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Finding the Right Business for You

by JoAnn Lombardi, Pres. of VR Business Sales

Before delving too deeply into the technicalities of due diligence when buying a business, remember the following point: Always focus on finding the right business before concerning yourself with the right price. Don’t base your search solely on finding a good deal or a steal….. Click here to read full article
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About VR Business Sales

VR Business Sales is the world’s premier business intermediary firm. With a combination of global strength and local experience, VR’s 30 years of successful business sales through Valued Representation, is the reason more and more business buyers and sellers demand our proven skills and resources to help them succeed in an increasingly complex market.

VR offers the best opportunity for owning a successful Business Sales Brokerage.

Contact our Director of Franchise Development at 800-377-8722 for more details about owning your own VR Business Sales Franchise Office.